India Inc must heed PM's call

T T Ram MohanMay 31, 2007, 04.02am IST

Many in the corporate world and the media have been dismissive of Prime Minister Manmohan Singh's impassioned call for restraint on executive pay in his speech at the CII last week. The PM did not hector, he merely appealed to industry's good sense.

That good sense is not showing. Executive pay, we are told blandly, must be market-determined. Whether the market does a good job of determining pay is controversial everywhere. Without getting into this controversy here, this much can be safely said: the prime minister's plea for moderation is not as outlandish as some would have us believe. For at least four reasons.

First, leaving aside the United States and, perhaps the UK, executive pay tends to be modest in most parts of the world. The knee-jerk response to this statement often is: that's why the US is a lot more dynamic than other economies. Well, there's a lot more to the dynamism of the US economy than big pay packets for executives — vibrant financial markets and huge subsidies for research coming out of defence budgets, for instance.

Besides, prosperity is not confined to the US and there is no dearth of successful firms in, say, France, Germany, Scandinavia, Switzerland and Japan. Clearly, economic success is not just about outsized pay for top executives. There is the danger that the Indian elite's admiration for things American may be leading to too close an emulation of the US economic model.

Secondly, the sharp rise in executive pay in the US has to do with a large variable component in the form of stock options. The argument for stock options is that by giving executives a long-term stake in their firms, it aligns incentives closely with performance. This is fine in a context in which firms, especially large firms, are run by professional managers.

But the Indian corporate landscape is very different. It is dominated by family-managed businesses and public sector firms. CEOs in family-managed businesses and often others at the top are from the family. They have large equity stakes in their companies. They receive substantial dividends that are not taxed in the recipient's hands. Why would they need to pay themselves huge salaries?

True, there are professionals as well at the top who need to be taken care of. But, even in the US, it is the CEOs who are incentivised the most. There is a chasm that separates the CEO's package from those of other executives.

Where the CEO is a family member, we have a built-in mechanism for moderating executive pay. The CEO does not need a big pay packet in order to deliver performance — his equity holdings provide all the incentive he needs. Once the CEO's pay is pegged at a reasonable level, reining in compensation down the line is not difficult.

Thirdly, the presence of the public sector in several areas of the economy provides a cushion against soaring pay in the private sector. Family businesses may have to compete for professionals with foreign firms who can offer internationally competitive pay.

But they have access to high quality talent in the public sector where compensation is way below that in the private sector. The public sector is apt to use private sector compensation to demand more pay. Maybe it is time to reverse the paradigm. How about benchmarking private sector compensation with pay in the public sector?

There has been vast improvement in the market value of several PSUs in the post-reform period. How do managers in PSUs rise to great heights without the bait of six-figure salaries and stock options? Perhaps, it is appropriate to recall text-book principles about motivation — pay matters but there are other elements as well, such as the challenge in the job, the culture of the firm, recognition, etc.

Fourthly, one is not sure that variable pay schemes in the Indian corporate world are rigorously designed. Are these related to absolute increases in share price or increases relative to the market or peers? If the former, we have a serious problem. In a booming economy that is exposed to foreign inflows, increases in share price may not be strictly correlated with company performance. Stock option schemes can easily yield undeserved gains to corporate bosses.

Industry must reflect carefully on the PM's call for restraint. The call comes from somebody who applauds industry's success but who also knows that the unabashed celebration of such success could create conditions that interrupt industry's dream run.

The PM's words are worth quoting, "I appreciate the fact that a corporate entity's primary responsibility is to its shareholders and to its employees. Your businesses have to be globally competitive. However, even to win this race, you must work in a harmonious environment..."